What is the lie of the land for workplace pension schemes?

In May, the Pensions Policy Institute (PPI) published its report Value for money in defined contribution (DC) workplace pensions. This considered the definition of value for money in this context, as well as how both members and employers can gain value from their schemes.

An increased focus on gaining value from workplace pension schemes has largely been driven by the number of developments in this market over the past few years. So, with this in mind, what is the current state of play? And what is next to come?

Where are employers with auto-enrolment?

We have got three to four million employees left to go but something in the region of 1.6m employers.

I think there is a very strong story about 90% of employees staying opted in. There is still no real sign of that dramatically changing. In other words, take up remains high despite lots of people suggesting it will get much worse.

What we have seen among small employers this year is quite a significant increase in the number of organisations complying late and therefore getting fined. There have been a lot of £400 spot fines issued by The Pensions Regulator. That is the more worrying aspect, rather than opt outs for employers.

What are the challenges ahead?

We are expecting half a million employers to set up a pension scheme this year. I do not think there have been half a million schemes in existence until now, which is quite a startling statistic. That is quite a large number of employers per working day this year to set up across the big peaks at the first of each month as the staging dates arise.

Beyond that, over the next three years, we have also got the increases in contribution levels for both employees and employers, allied with the introduction of the national living wage. An increase in contributions at exactly the same time as increases in the national living wage are quite big challenges and we should not underestimate the impact on small businesses.

I do not think we have seen the true impact yet. When you start to look at contributions going up to 2% or 3% from the organisations, allied with the increase in the national living wage, in time will that mean overall that it will stifle growth for organisations in this continued low-growth environment? It is unclear. And what will they do to mitigate that? Some will certainly look at cutting costs in other places to ensure they comply but that is not a huge surprise. Australia went through that experience 20 years ago and actually agreed with unions how employers would curtail pay rises in order to fund pensions. The only big difference here is that we are in a sustained low-growth environment.

What have we learned so far?

One of the key things is that the nudge of putting people into a pension has proved to be a really successful one. Some people say that opt-out rates among young people are lower than expected. The reality is that young people are more inclined to stay in than people that are closer to retirement.

One way or another the nudge is working. It is about getting people to do the right thing without having to engage with it. The interesting thing then is how we might consider applying similar nudges in other aspects of financial planning. Should we be nudging people into taking out life insurance at the point they get married or have their first child, for example?

Coming back to auto-enrolment, we have talked extensively about charges and will continue to do so, but in a charge-capped world, we need to turn full attention to other things that actually make a bigger difference.

Investment return is a really good example. Charges might differ in schemes by a quarter of a percent or something to that order, whereas investment returns for the first three years of default funds under auto-enrolment have differed by several percentage points. The best-performing default funds have returned towards 9-10% per annum, while the lowest-performing funds have returned more like 3%. So that variation is much greater than any we have in charges under the charge cap. That is an interesting one. There is much more variability in investment returns than charges.

What can we expect next from government?

It always had a planned review in 2017 which would review auto-enrolment in its entirety but would also focus on things like: have we got the right earnings trigger and the right earnings definition, is the charge cap suitably inclusive, is it set at the right level, are there other aspects of governance we should consider? Obviously there are aspects of how the National Employment Savings Trust (Nest) is performing and its function.

What really matters to employees?

The PPI report points to contribution rates being one of the determinants of outcomes at retirement, so things like matching contribution rates or auto-escalation really matter to employees, even if they do not recognise it at the very outset. Investment returns are undoubtedly a big factor.

The support [people] get in making decisions at retirement is another thing. Put simply, somebody could save at the maximum rate throughout their working life, get the best investment returns with the lowest charges in a fantastic scheme, but then hand all of the money to someone who invests it poorly at retirement and loses it. In other words, they could fall foul to a scam or a very high risk investment scheme, which would render everything they have done before that pointless.

So, decisions at retirement have to be considered hugely important in the equation of member outcomes and what value they are getting.